Thursday, June 17, 2010

On Wednesday, the Federal Housing Finance Agency announced it would de-list both Freddie Mac and Fannie Mae from the New York Stock Exchange.

As the FHFA stated, Fannie Mae’s closing stock price had been below the required $1 average price for the past 30 trading days. And so:

Per NYSE rules, a company in that condition must either drop from the exchange or undertake a ‘cure’ to restore the stock price above the $1 mark if it does not meet the NYSE’s minimum price requirements.

Freddie Mac’s de-listing, however, was purely a voluntary move by the agency. As they explained:

“A voluntary delisting at this time simply makes sense and fits with the goal of a conservatorship to preserve and conserve assets,” said DeMarco.

But none of that is what’s really interesting.

What is interesting, is how the stocks behaved immediately after the announcement.

(Note that the two companies will only begin trading over-the-counter from July 8 onwards, and they both remain listed until then).

Anyway, here’s Fannie:

And here’s Freddie:

Both charts reflect a big fall in stock value as well as a sizable surge in volumes traded.

Which is interesting since the Zero Hedge blog has been writing for a while about how trade in Freddie and Fannie, alongside other low-priced stocks like AIG and Citi, has on occasion amounted to 20 per cent of total market volume on no news whatsoever in the last year.

The big difference at those times, however, was that the value of the stocks was actually boosted:

With that in mind, it’s worth pointing out that the SEC is currently seeking public comment on whether or not there may be a larger than normal incentive for broker-dealers to internalise trades in stocks that are low priced and plentiful in number. Which, of course, would be stocks like Freddie and Fannie.

In low-priced stocks, the minimum one cent per share pricing increment of Rule 612 of Regulation NMS is much larger on a percentage basis than it is in higher-priced stocks. For example, a one cent spread in a $20 stock is 5 basis points, while a one cent spread in a $2 stock is 50 basis points – 10 times as wide on a percentage basis. Does the larger percentage spread in low-price stocks lead to greater internalization by OTC market makers or more trading volume in dark pools?

You can read more about the so-called ‘sub-penny’ arbitrage here and here.

The point, however, is that if such favourable opportunities exist in low priced and plentiful stocks (especially for broker-dealers who can internalise trades), you can bet they only really make money when the trades are conducted at very high volumes, and very very quickly.

In other words, it’s an arbitrage opportunity for algorithmic high frequency trading broker-dealers in particular.

The fact that Wednesday’s high volumes came alongside large and sudden drops in the stocks’ values, would hence suggest the moves are simply the result of some large-scale unwinding of algorithmic programmes by broker-dealers in anticipation of the stocks’ de-listings.

And those are the same programmes which probably contributed to driving up the stocks’ prices in high volume trading beforehand.

In short, de-listing clearly equals the end of a unique high-frequency arbitrage opportunity for some.